Monday, June 23, 2008

Is America De-leveraging?

One of my favorite books is The Tipping Point. It is a fascinating look at a range of situations using unconventional economic theory. After re-reading portions of it recently, I have begun to focus on what I think may be two areas where we have “tipped” and things will never be the same. The obvious one is energy and its ramifications are being addressed in the media so I will not repeat them here.

The other less obvious one is what I call the de-leveraging of America. First, the good news is that corporate America, with the huge exception of investment banks, has already completed this process. The vast majority of large corporations have used their cash flows and attractive equity market conditions in recent years in a manner that has left their balance sheets in excellent condition. But, some of those same companies were encouraging their customers to do just the opposite. (What’s in your wallet? Don’t leave home without it. Isn’t it about time for your home to start paying you?) The result is that American consumers are more heavily in debt than at any time in our history. The level of debt has been setting records for years now, drawing continuing comments from economists. Which brings to mind that sage economist’s comment, “Things that cannot go on forever tend not to!” Or, we have finally “tipped” and things will not be the same. Parenthetically, I would add that the ‘baby boomers’ finally reaching retirement age is a big factor in all of this. Which reminds me of one of my favorite books from some years ago, Mega-Trends. But, I digress. The mortgage crisis, I believe, is just a sub-component of this broader trend toward de-leveraging. We are already beginning to hear of home-equity and other consumer loans as the next big problem areas. If we sink deeper into recession as some believe, these portfolios will only come under more and more stress.

I believe every business in America, particularly the banks, needs to assess how this de-leveraging will impact their business. As consumers are able to repay their debts, don’t expect them to return to their profligate ways, even with your most clever advertising. As to real estate, we have also reached the point where home buyers are looking at things very differently. Or, as a person on television today said, ‘until we reach a point where buyers once again view a home purchase as consumption instead of an investment, we will not know the true value of homes’. Sounds like a tipping point within a tipping point. Like any change of this magnitude its effects will not just be negative. Big opportunities will be created for prescient companies to exploit.

Tuesday, June 17, 2008

Bank of America CountryWide Watch - Update

The stock market was not kind to banks today on fears of additional write-offs and possible dividends cuts. BofA in particular was noted in this regard as it set a new 5 year low below $30. One year ago the stock traded at over $50 with the decline amounting to about $100bb in shareholder value. Their common stock now yields 8.75% which means the market is betting on a cut in their dividend. The CountryWide acquisition is largely viewed by analysts as ill-conceived and adding more risk to an already risk-laden business. Yet the bank seems determined to go forward.

I like to contrast BofA to U S Bank. U S has chosen a very different path. It has carefully selected its business lines and manages risk with even greater care. Its acquisitions are also carefully strategic in nature. While BofA's stock this past year dropped over $20 to below $30, US Bank has seen its stock slip a mere $3 to $31. Wonder why Warren Buffet owns US Bank and not BofA?

Thursday, June 5, 2008

Bank of America CountryWide Watch 2

The Fed today approved the merger. Now it seems they only need shareholder approval which I believe is later this month. So, it looks as if they are staying the course despite calls for them to get out of the deal. And get out they could. I'm sure the controlling purchase agreement has sufficient language regarding deterioration and legal issues that they could easily kill the deal with no risk of legal retribution. Business deals are often driven by ego & stubbornness, and I think that is what we are seeing here.

BofA will follow one of two options. One, as I have written earlier is just to write down the value of CountryWide's loans just prior to closing. And, I mean REALLY write down to cover their worst case scenario. This will result in booking a relatively large increase to their goodwill account but not doing the deal would mean a write-off of their Preferred stock investment and the various extensions of credit to CountryWide. I wrote about this in more detail in an earlier article. Essentially this is just a clever way to transfer their loss to the goodwill account. The other option for them is to go the bankruptcy route as I also wrote about in an earlier article. It will be fascinating to see how they proceed.